WASHINGTON — The recent changes in the communication framework of the Federal Open Market Committee leaves open the possibility of changes in monetary policy, such as a lowering of the central bank's employment threshold, according to Minneapolis Federal Reserve Bank President Narayana Kochlerkota.
The Minneapolis Fed published its 2012 Annual Report Monday, which features an interview with President Kocherlakota conducted after the FOMC's December meeting.
The December meeting was when the FOMC announced interest rates would likely need to remain at exceptionally low levels so long as unemployment stayed above 6.5% and inflation did not threaten to hit 2.5% or more.
"I also think that the statement gives us the freedom to do more - for example, by lowering the unemployment threshold," said Kocherlakota, who does not hold a voting position on the FOMC this year.
By setting the unemployment threshold as high as it did, Kocherlakota said the FOMC "left an opportunity out there for improvement."
He argued that having it so high means the American public is left thinking that "the Committee could well be planning to retard the pace of economic recovery while the unemployment rate remains noticeably above our long-run estimates."
While the Fed risks it credibility if it were to toy with the inflation mark, the case is different with unemployment.
"I worry that we'll come to a point where we're going to want to do this later anyway -- that is, lower the unemployment threshold -- and we'll have lost all the stimulus we could have provided in the intervening period by lowering it ahead of time," he said.
This is why Kocherlakota would prefer the FOMC to lower its unemployment threshold to 5.5%, an idea he first raised during a speech in Ironwood, Michigan in September last year.
"I think our communication leaves open the possibility of improving policy by lowering the unemployment threshold," he said. "But that is an opportunity for improvement that is out there for the Committee, I think."
Setting the threshold at 5.5% would lower confusion, he said. "I think it's clearly smack dab in the middle of where the Committee sees the unemployment rate settling down to in the long run."
"That's what I think this policy is about: letting the public know that we're not going to get in the way of the economic recovery by raising rates, until such time as the recovery is closer to being complete," Kocherlakota concluded.
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